March 11, 2015

Listing

Why do you need an exchange?

Between the Tiber River and the Piazza del Quirinale in Rome sit the remains of Trajan’s Market, built around 100 AD by that Roman emperor famed for militaristically expanding the empire to its zenith.

Considered the world’s first covered multistory shopping mall, Trajan’s Market, designed by Greek Damascan architect Apollodorus, ingeniously and conveniently clustered vendors and shoppers. Thus that era’s real estate industry saw the importance of location, a timeless lesson.

Taking queue from the ancients, our financial forebears on Broad Street in New York City similarly fashioned a marketplace in 1792, after for some time trading stocks under a buttonwood tree. The bazaar they birthed called the New York Stock Exchange aggregated the investors with cash and the growth enterprises needing it. Investing leapt toward the modern era.

That worked well until exuberance and mushrooming Federal Reserve currency supplies collided in 1929. Then the government said, “All right, everybody, out of the pool.”

With the Securities Act of 1933 and the Securities Exchange Act of 1934, the government sought to introduce safety to markets by eradicating fun and frivolity.  No longer would stock brokers hold court without a king, insouciantly supposing they could match buyers and sellers on merits without a bunch of paperwork with alphanumeric identifiers that governments so prefer.

As a result, some 82 years after Government ordered everybody to stand in lines and fill out forms, public companies in these here United States in 2015 need an exchange to list shares if they want the public to trade them (there are exceptions on the smaller end, the over-the-counter market, which has many thousands more companies than the big National Market System – but that’s a story for another time).

The question now is does it matter where you list your shares? We can prove in less than a blink of an eye that location, location, location is irrelevant (that should be our first clue that something is amiss) today in the equity market.

No, really.  We can show you in a split-second.  If you’ve never seen it, watch these ten milliseconds (the blink of an eye is about 300 milliseconds) of MRK trading compiled by data firm Nanex and posted to Youtube.

From the moment your shares begin to trade the same rules affect them everywhere, the same 30 firms – half big brokers working customer orders and half proprietary intermediaries – will execute 90% of your volume. The same essential order types powered by the same data (proprietary feeds faster than public ones) will interact with algorithms making bids and offers around price standard-deviation.

At the video above, the four-letter descriptors you see comprise the National Market System for displayed prices (the SIP is the consolidated tape – the “ticker tape”), and all the big exchanges own multiple platforms.  NYSE and PACF (Arca) are NYSE.  BATS Y and S and EDGE and EDGX are owned by BATS, with Y and X in the same Weehawken NJ data center and all four will soon be in a Secaucus NJ colocation facility.   In fact, all the servers for all the exchange platforms are in NJ.

NQEX, BOST and PHIL are Nasdaq markets with variable fee structures.  The Big Three operators offer multiple platforms for that reason – to vary fees and structures. Why? It encourages more activity, which one could construe as confusing busy with productive (for the benefit of the intermediaries, not their customers) if we compared it to the Trajan model from 100 AD.

For instance, at BOST if you’re a broker buying 10 basis points (0.10%) of all daily volume there, you can earn a trading rebate of $0.15 per hundred shares purchased (yes, paid to buy).  If you’re in the top volume tier, you can also be paid $0.17/100 to “display liquidity,” which means offering shares for sale via automated quotes.

All the exchanges and platforms nuance fees based on volume and buying or selling. Why? To encourage buying and selling, so that frenzied commerce will set prices and create valuable data for the exchanges to sell back to buyers and sellers at high cost (the government requires trades to occur at the best price, so whose fault is it really?).

Listings are the product that gets relentlessly priced. The best profits for exchanges are in opening and closing auctions used heavily by indexed money, and listing a company’s shares confers the right to host those.  Index/ETF flows dominate now and want to track the benchmarks to which the money is pegged. Auctions offer the best means (though dark pools are compelling too).

Moral of the story:  In 100 AD Trajan aggregated demand and distribution by building a beautiful marketplace bringing these functions together. Brokers in 1792 took that cue.

In 2015, the markets themselves divide like cells into more markets to disperse demand and distribution profitably.  Is this a good deal?  What would Trajan say?

It’s essential to understand how the market functions if you’re to know whether you’re paying for something valuable or not.  One could argue today that issuers are the most valuable commodity in the stock market. So for what, exactly, are public companies paying?

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